Incorporating as a "New Every Two" Landlord

13 Replies

I am planning to invest in real estate using the new every two strategy with a twist. Instead of selling after two years, I plan to keep my previous properties as rentals. I have a full-time job, so saving up 20% down payments (which is required now for investment properties, right?) will take more years than I have patience for unless I'm buying $50k houses. I have two questions (well, three if you include the one in the last sentence):

1) Am I correct in assuming that I must remain an owner occupant for a minimum of two years? I know that's required if you're planning to sell, but I'm not sure if selling is the same as just moving out & moving someone else in.

2) How and when does incorporating come into the picture with this strategy? I am in Virginia if that has an effect on the answer.

Thanks!

@Amos Shenk your post implies that you are selling your personal residence every two years to take advantage of the tax free (exemption of up to 250k single or 500k married) gains from sale.

The two year rule is based on the IRS set time period for selling your personal residence without getting taxed on the gain. The two year rule can be prorated if you live in the property less than the two years prior to selling it. Your accountant can explain the formula. The two year rule only matters if you sell the property when you've lived in it two out of the last five years IF you sell before that five years is up.

In my market, you have to be a cash buyer to compete for investment properties. Conventional financing does require 20% DP, but there are other options. You could get Homepath investor financing (look for the list of lenders on their website) with 10% DP.

Alternatively, you could buy low enough with cash, to "cash out refinance" and get all of your initial investment back to invest in your next property. That can be done using a commercial lender who is a "portfolio lender" and the usual seasoning requirements don't apply. Lots of people will tell you that's not possible, but I'm not guessing or telling you about a cool idea I found on the Internet - I do it and others do to.

When to incorporate or form an LLC is an asset protection question that you have to figure out with your attorney and CPA.

Typically loan documents require you to live in the house for 1 year if you get an owner occupant loan. As @Robert Leonard stated, the every 2 year rule has to do with selling tax free (and wouldn't really apply to your situation).

I don't think you need to incorporate for quite a few years. Just buy extra liability insurance as your portfolio grows. But my advice is worth what you are paying for it.

@Robert Leonard @Steve L. Thank you both for your responses. So in a nutshell, unless I sell the property within 5 years of purchasing it, then I am not required to stay in it for any longer than 1 year. However if I move out before 2 years is up, then end up selling before the 5 year mark, I'll be taxed on my gain.

Please point out any flaws in this plan: Buy/live in/rehab one property per year. Then after I have acquired x amount of properties, incorporate (where x will be determined with the help of my attorney & CPA).

I realize that buying with less than 20% DPs subtracts from cashflow, but what I'm seeing is that in 3 years I'll own 3 properties. It's hard to wrap my head around since I've never done it before, but what I see is this: In the next 3-4 years I could own 3-4 $100/month cashflow properties (I definitely won't knowingly buy anything that brings in less) OR save 20% for one--I used my current income to calculate these numbers. Thoughts? Wisdom? Is it worth it to take a few years to save up for a higher DP?

I guess I could also still hold to the every two years mark, that way if I run into trouble with a property I can sell it and keep the gain. I think this is where someone will step in and say, "You can make 100 plans, but if you don't start and stick to one of them, you'll just keep running in circles!"

Originally posted by @Amos Shenk :
I am planning to invest in real estate using the new every two strategy with a twist. Instead of selling after two years, I plan to keep my previous properties as rentals. I have a full-time job, so saving up 20% down payments (which is required now for investment properties, right?) will take more years than I have patience for unless I'm buying $50k houses. I have two questions (well, three if you include the one in the last sentence):

1) Am I correct in assuming that I must remain an owner occupant for a minimum of two years? I know that's required if you're planning to sell, but I'm not sure if selling is the same as just moving out & moving someone else in.

2) How and when does incorporating come into the picture with this strategy? I am in Virginia if that has an effect on the answer.

Thanks!

With Rentals you never incorporate, you may form an LLC at some point; however, liability insurance is often best in the beginning if you do not have a ton of assets already.

Medium hta logoSteven Hamilton II EA, Hamilton Tax and Accounting | [email protected] | (224) 381‑2660 | http://www.HamiltonTax.Net

@Steven Hamilton II Ah, that is very helpful! I will remember that and turn my research in that direction. Thank you.

I think you are mixing up strategies in your head a bit.

After you own a property for 1 year (primary residence or not) any profits are taxed at a long-term capital gain rate.

There is a special law, if you occupy a property as your primary residence for 2 of the last 5 years, any gains up to $250,000 ($500,000 if married) are tax free.

So if your plan was to buy a property every year, the primary residence exclusion wouldn't apply. Which is fine.

Now to address the incorporation question: you are wanting to get a primary residence loans (because they are a better rate and require less down payment). These loans can only be given to you in your personal name. You could technically transfer them to your LLC later, but this would probably violate your lenders due on sale clause.

I think the strategy is very good. To move every year and rent the previous house. Keep in mind after 4 loans you will have more issues getting future loans. If I were you, I would no bother incorporating until you own 4 properties. A lot can change in 4 years and you can ask your lawyer/tax guy if that would be beneficial at that time.

we buy both investments and personal properties. Investment are 20% down and personal is 5% for conventional occupants. As long as you can "prove" a reason to the bank you can buy a new personal and move every year. If you goal is buy and hold, I would move very year until that is not an option. When my husband and I did the numbers. We found that in 15 the house that was an owner occ. with lower interest payment versus investment with 20# down but higher interest payment. They worked out to 4 months difference on there assumption that all the extra "cashflow" went into your house.

Personally we are a big believer in buying as many personal properties turn rentals as you can legally.

@Steve L.

After you own a property for 1 year (primary residence or not) any profits are taxed at a long-term capital gain rate.

I'm still a bit confused with this part. Does "any profits" basically mean cashflow from the property? Bear with me, I have to put it all in Rich Dad Poor Dad terms as I am still learning the vocabulary of the REI world! So for easy math, if I made $100 off of a property in a year, and the long-term cap gain rate for that year (for my bracket) is 15%, I'll pay $15 on it.

There is a special law, if you occupy a property as your primary residence for 2 of the last 5 years, any gains up to $250,000 ($500,000 if married) are tax free.

If I don't occupy for at least 2 of the last 5 years and I sell, and I make a profit of $100,000,000 (Why not dream big?), then I'll pay my short-term capital gain rate (same as my income tax rate) on that $100,000,000. So if I'm in the 35% bracket, I'll pay $35,000,000. Please correct me if I'm wrong!

So if your plan was to buy a property every year, the primary residence exclusion wouldn't apply. Which is fine.

If nothing else, I do understand this part.

Now to address the incorporation question: you are wanting to get a primary residence loans (because they are a better rate and require less down payment). These loans can only be given to you in your personal name. You could technically transfer them to your LLC later, but this would probably violate your lenders due on sale clause.

Just read this in here. Thinking ahead, could I find a lender whose due on sale clause would not be triggered by moving to an LLC, or do they all do this?

I think the strategy is very good. To move every year and rent the previous house. Keep in mind after 4 loans you will have more issues getting future loans. If I were you, I would no bother incorporating until you own 4 properties. A lot can change in 4 years and you can ask your lawyer/tax guy if that would be beneficial at that time.

Thank you, I hope the strategy is very good too. I really like the idea--I am pretty fresh out of college, so I am used to moving in and out of places quite often. I enjoy it. Change of scenery, meeting new people... and it keeps me focused on not wasting money and accumulating too much stuff because I always know that I'm going to have to move it soon. I guess you could call me the new age drifter.

Elizabeth Colegrove Thank you (and your husband) for your response and your numbers, it really helps. I am feeling more confident that investing early and often is a good plan and is going to work out well for me in the future. The thing I have been most concerned about with my plans is that I'll be biting off more than I can chew without really knowing what I'm eating!

That feeling is going away now, as I can see now that it is definitely possible to buy at the very least 4 properties in the next 4-5 years while keeping my full-time job. And 4-5 years is plenty of time to learn more about financing options for that next step into 5+ properties. Not to mention that in the meantime I'll be learning what it's like to have tenants!

@Amos Shenk

I wouldn't incorporate right now. Long story short. We did and we unincorporated because it wasn't worth it.

We have 5 houses, 4 rental right now with one short sale in the works and one offer out, sellers still thinking about it. We bought our first house 2.5 years ago, our first pure investment 1.5 years ago. We did baby steps. We both work full time and I also manage 4 of my parents properties.

For me the importance of setting up procedures and doing everything right the first time has been the key to my success. If you take the extra minute to put the right tenants in the house and have a detailed lease. Alot of little issues won't crop up as easily because they are covered

After you own a property for 1 year (primary residence or not) any profits are taxed at a long-term capital gain rate.

I'm still a bit confused with this part. Does "any profits" basically mean cashflow from the property? Bear with me, I have to put it all in Rich Dad Poor Dad terms as I am still learning the vocabulary of the REI world! So for easy math, if I made $100 off of a property in a year, and the long-term cap gain rate for that year (for my bracket) is 15%, I'll pay $15 on it.

Rental income is taxed at your regular tax rate (similar to earned income). Profit on the sale are handled by long-term or short-term capital gain tax.

There is a special law, if you occupy a property as your primary residence for 2 of the last 5 years, any gains up to $250,000 ($500,000 if married) are tax free.

If I don't occupy for at least 2 of the last 5 years and I sell, and I make a profit of $100,000,000 (Why not dream big?), then I'll pay my short-term capital gain rate (same as my income tax rate) on that $100,000,000. So if I'm in the 35% bracket, I'll pay $35,000,000. Please correct me if I'm wrong!

Not really. If you own it over 1 year, it is "long-term capital gains," whether you occupy it or not. If you own it under a year, it is the "shot-term capital gain" and taxed usually the same as the bracket you are in.

So if your plan was to buy a property every year, the primary residence exclusion wouldn't apply. Which is fine.

If nothing else, I do understand this part.

Now to address the incorporation question: you are wanting to get a primary residence loans (because they are a better rate and require less down payment). These loans can only be given to you in your personal name. You could technically transfer them to your LLC later, but this would probably violate your lenders due on sale clause.

Just read this in here. Thinking ahead, could I find a lender whose due on sale clause would not be triggered by moving to an LLC, or do they all do this?

Any lender that doesn't have a due on sale clause will not give you the good owner occupied primary residence terms. Most banks that lend to entities are 70% LTV, 5%+ etc.

I think the strategy is very good. To move every year and rent the previous house. Keep in mind after 4 loans you will have more issues getting future loans. If I were you, I would no bother incorporating until you own 4 properties. A lot can change in 4 years and you can ask your lawyer/tax guy if that would be beneficial at that time.

Thank you, I hope the strategy is very good too. I really like the idea--I am pretty fresh out of college, so I am used to moving in and out of places quite often. I enjoy it. Change of scenery, meeting new people... and it keeps me focused on not wasting money and accumulating too much stuff because I always know that I'm going to have to move it soon. I guess you could call me the new age drifter.

Wait until you get married... your significant other might have a different theory in life.

Originally posted by @Steve L. :

Wait until you get married... your significant other might have a different theory in life.

That is in the works as well... I'll be asking her today what she thinks about moving every year! Thanks for all your help, Steve.

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